International Bond
What is an International Bond
An international bond is a debt investment that is issued in a country by a non-domestic entity.
International bonds are issued in countries outside of the United States, in their native country's
currency. They pay interest at specific intervals, and pay the principal amount back to the bond's
buyer at maturity.
BREAKING DOWN International Bond
As the business world becomes more globalized, companies now have ways to access cheaper
sources of funds and financing outside of their country of operations. Instead of relying on
investors in the domestic markets, businesses and governments can tap into the pockets of global
investors for much needed capital. One way through which companies can access the
international lending scene is by issuing international bonds.
HISTORY OF INTERNATIONAL BOND MARKET
International Bond Market has long history. It dates back several centuries. Many wars have
been fought by kings funded by borrowing money from other royal houses from different
countries. Though it is beyond the scope of this session to discus the long history of bond market
in detail, one interesting study in worth mentioning here. Ferguson’s 2006 paper studied impact
of political risk on international bond market during two distinct periods – 1843 between the
1880 and during 1880-1914. This clearly indicates that international bond market was active
even during middle of nineteen century.
FEATURES OF INTERNATIONAL BOND MARKET
• It is a debt market.
• It is a fund raising market.
• Fixed income instrument.
• Issued in foreign currency.
• It channelizing savings.
TYPES OF BOND MARKET
An international bond is issued in a country or currency that is not domestic to the investor. From
the perspective of a domestic investor and resident of the United States, an international bond is
one that is issued by corporations or governments in other countries denominated in a currency
other than the U.S. dollar. These bonds are issued outside of the United States and are generally
backed by the currency of the native country. International bonds include eurobonds, foreign
bonds, and global bonds.
1. Foreign Bonds
In foreign bond market, bonds are issued by foreign borrowers. Foreign bonds normally use the
local currency. The concerned local market authorities supervise the issuance and sale of foreign
bonds.
Foreign bonds are traded in the foreign bond markets. Some special characteristics of the foreign
bond markets are −
• Issuers of bonds are usually governments and private sector utilities.
• It is a standard practice to underwrite and organize underwriting the risks.
• Issues are generally pledged by the retail and the institutional investors.
In the past, Continental private banks and old merchant houses in London linked the investors
with the issuers.
2. Eurobonds
this is a bond that is issued and traded in countries other than the country in which the bond’s
currency or value is denominated in. These bonds are issued in a currency that is not the
domestic currency of the issuer. A French company that issues bonds in Japan denominated in
U.S. dollars has issued a Eurobond, more specifically, a Eurodollar bond. Other types of
Eurobonds are the Euroyen and Euroswiss bonds.
FEATURES OF EUROBONDS
• Underwritten by an Internationally.
• Offered simultaneously to investors in a number of countries.
• Issued outside the jurisdiction of any single country.
• They are not registered through a regulatory agency.
• Make coupon payments annually.
• Large in size offered for simultaneous placement in different countries.
UNIQUE CHARACTERISTICS OF EUROBONDS
• Face value: The face value is the amount of money a holder will Get back once a bond mature.
• Coupon (the interest rate) : The coupon Is the amount the bondholder will receive as interest
payment, it is called coupon. Because in early days their were physical coupons attached to the
bond certificate.
• Maturity: It is the date in future on which the investors principle will be repaid
• Issuer: Eurobonds are mostly issued by corporate.
• Denominations: Eurobonds are commonly denominated in a number of currencies. Although
the us $ is used most often, denominating 70-75 percent of Eurobonds. The euro will likely also
be used to a significant extent in the future.
• Secondary Market: Eurobonds also have a secondary markets. The market makers are in many
cases the same underwriters who sell the primary issues. A technological advance called Euro-
clear helps to inform all traders about outstanding issues for sale, thus allowing a more active
secondary market.
• Ratings: The bond rating system helps investors to determine a company’s credit risk.
• Taxation: Eurobonds are not subject to tax largely free from government regulation.
Pros of Eurobonds
1. It would prevent repeated financial crisis that is creating a destabilising economic and political
environment.
2. Investors would have greater security in buying the bond because overall Eurozone debt is
manageable.
3. Interest rate costs would fall for several countries; this would give them much greater ability
to repay outstanding debt rather than just keeping up with interest payments.
4. It would mean secure countries wouldn’t need to get involved in bailout packages.
5. Austerity measures to try and contain the debt crisis threaten to cause a double-dip recession.
For example, Italy is facing the prospect of a second economic downturn because of necessity to
cut spending to deal with fears over rising debt costs (despite having a primary budget surplus)
Eurobonds which give greater security would give countries more time in reducing long term
deficits without sacrificing growth.
6. Logical conclusion of single currency. A common monetary policy and common currency
needs a single fiscal policy to ensure economic harmonisation.
7. Countries in Eurozone suffer from inability to print money and avoid liquidity shortages. The
experience of recent months suggests it is more difficult for countries in the Eurozone to borrow.
The lack of an independent Central bank to avoid temporary liquidity shortages makes members
of the Euro much more vulnerable to panic selling of bonds.
Cons of Eurobonds
1. It is unfair to countries who have avoided debt crisis through fiscal responsibility. Germany
will see their interest rate costs rise, closer to the Eurozone average. This is why it is politically
unpopular in Germany.
2. Moral Hazard. If countries can benefit from overall Eurozone average, there may be less
incentive to reduce wasteful spending and borrowing. Because debt will be secure, it may
encourage countries to borrow more than prudent because they don’t have the same incentive to
reduce borrowing.
Difference between Eurobonds and foreign
A Eurobonds is a bond that is issued by an international borrower and sold to investors in
countries with currencies other than the currency in which the bond is denominated. An example
of a Eurobond is a dollar-denominated bond issued by a U.S. company and sold to Japanese
investors. A Eurobond is typically issued in a single currency (frequently dollars) in many
countries. By selling Eurobonds, many multinational companies finance their global operations
especially in the countries in which they are do business. Eurobonds are also a source of
intermediate and long-term financing of sovereign governments and Supra nationals.
In contrast to a Eurobond, a foreign bonds is a bond issued in a host country’s financial market,
in the host country’s currency, by a foreign borrower. This bond is subject to the regulations
imposed on all securities traded in the national market and sometimes to special regulations and
disclosure requirements governing foreign borrowers. Many of these issues have colorful
nicknames such as:
Yankee bonds: dollar-denominated bonds which are issued by non-American borrowers in the
U.S. market.
Samurai bonds: yen-denominated bonds which are issued by non-Japanese borrowers in the
Japanese market.
Bulldog bonds: pound sterling-denominated bonds which are issued by non-British borrowers in
the British market.
Heidi bonds: franc-denominated bonds which are issued by non-Swiss borrowers in the Swiss
market.
Rembrandt bonds: guilder (now euro)-denominated bonds which are issued by non-Dutch
borrowers in the Dutch market.
Matador bonds: peseta (now euro)-denominated bonds which are issued by non-Spanish
borrowers in the Spanish market.
For example, in the United States, Yankee bonds are registered with the Securities and Exchange
Commission (SEC), and like other U.S. bonds, their interest is paid semi-annually. Sovereign
government issues or issues guaranteed by sovereign governments tend to denominate the
Yankee bond market.
3. GLOBAL BOND
Global bonds are bonds issued and traded simultaneously in the U.S. market (Yankee bonds) and
in the Eurobond market. Only very large, high quality, regular bond issuers can access the
global bond market. These usually are the bonds issued by governments (sovereign debt).
Note: Non-U.S. sovereign debt issuers are assigned two ratings by the credit-rating agencies:
1. A local currency credit rating
2. A foreign currency credit rating
There are two ratings because while sovereign governments can print money to pay debt service
requirements on their own currency, they cannot print the funds necessary to pay debt service
requirements in a foreign currency. Thus, default tends to be higher on bonds that are
denominated in a currency that is different from the home currency of the sovereign
government’s own currency. If a government’s home currency depreciates relative to currencies
in which its bonds are denominated, the ability to pay the debt service on the foreign-pay bonds
declines substantially
Types of Instruments
• Straight Fixed Rate Debt.
• Floating-Rate Notes.
• Equity-Related Bonds.
• Zero Coupon Bonds.
• Dual-Currency Bonds.
• Composite Currency Bonds.
Straight fixed-rate bond issues have a designated maturity date at which the principal of the bond
issue is promised to be repaid. During the life of the bond, fixed coupon payments that are some
percentage rate of the face value are paid as interest to the bondholders. This is the major
international bond type. Straight fixed-rate Eurobonds are typically bearer bonds and pay coupon
interest annually. Floating-rate notes (FRNs) are typically medium-term bonds with their coupon
payments indexed to some reference rate. Common reference rates are either three-month or six-
month U.S. dollar LIBOR. Coupon payments on FRNs are usually quarterly or semi-annual, and
in a accord with the reference rate. A convertible bond issue allows the investor to exchange the
bond for a pre-determined number of equity shares of the issuer. The floor value of a convertible
bond is its straight fixed-rate bond value. Convertibles usually sell at a premium above the larger
of their straight debt value and their conversion value. Additionally, investors are usually willing
to accept a lower coupon rate of interest than the comparable straight fixed coupon bond rate
because they find the call feature attractive. Bonds with equity warrants can be viewed as a
straight fixed-rate bond with the addition of a call option (or warrant) feature. The warrant
entitles the bondholder to purchase a certain number of equity shares in the issuer at a pre-stated
price over a pre-determined period of time. Zero coupon bonds are sold at a discount from face
value and do not pay any coupon interest over their life. At maturity the investor receives the full
face value. Another form of zero coupon bonds are stripped bonds. A stripped bond is a zero
coupon bond that results from stripping the coupons and principal from a coupon bond. The
result is a series of zero coupon bonds represented by the individual coupon and principal
payments. A dual-currency bond is a straight fixed-rate bond which is issued in one currency and
pays coupon interest in that same currency. At maturity, the principal is repaid in a second
currency. Coupon interest is frequently at a higher rate than comparable straight fixed-rate
bonds. The amount of the dollar principal repayment at maturity is set at inception; frequently,
the amount allows for some appreciation in the exchange rate of the stronger currency. From the
investor’s perspective, a dual currency bond includes a long-term forward contract. Composite
currency bonds are denominated in a currency basket, such as SDRs or ECUs, instead of a single
currency. They are frequently called currency cocktail bonds. They are typically straight fixed-
rate bonds. The currency composite is a portfolio of currencies: when some currencies are
depreciating others may be appreciating, thus yielding lower variability overall.
COMMON PROCESS OF ISSUING NEW BOND
A borrower desiring to raise funds by issuing Eurobonds to the investing public will contact an
investment banker and ask it to serve as lead manager of an underwriting syndicate that will
bring the bonds to market. The lead manager will usually invite other banks to form a managing
group to help negotiate terms with the borrower, ascertain market conditions, and manage the
issuance. The managing group, along with other banks, will serve as underwriters for the issue,
i.e., they will commit their own capital to buy the issue from the borrower at a discount from the
issue price. Most of the underwriters, along with other banks, will be part of a selling group that
sells the bonds to the investing public. The various members of the underwriting syndicate
receive a portion of the spread (usually in the range of 2 to 2.5 percent of the issue size),
depending upon the number and type of functions they perform. The lead manager receives the
full spread, and a bank serving as only a member of the selling group receives a smaller portion.
Risk You Should Know Before Investing In International Bond Fund
1. Sovereign or credit risk
Sovereign risk is the risk that a national government will fail to make timely payments on the
debt it issued or actually default on its debt obligations. For non-governmental borrowers,
sovereign risk is known as “credit risk.” For example, the iShares International Treasury Bond
ETF (IGOV), which invests in sovereign debt issued by developed market governments, will
have sovereign risk, while the bonds included in the iShares iBoxx $ Investment Grade
Corporate Bond Fund (LQD), which invests primarily in U.S. domestic corporate bonds, would
have credit risk.
2. Interest rate risk and duration
Like domestic bonds, interest rate risk also affects international bonds. Bond prices fall when
interest rates increase and vice versa. Durations measure price sensitivity in bonds due to parallel
shifts in the yield curve. The higher the bond or the bond fund’s duration, the greater the price
change for a given change in the interest rate, all else being constant. For example, the duration
for the Emerging Markets Sovereign Debt Portfolio ETF (PCY) is estimated at ~8.6, while the
duration for IGOV is estimated at ~6.95 years. This implies PCY has lower interest rate risk than
IGOV in terms of duration.
For more on duration and how it affects your fixed income portfolio, please read the Market
Realist series Interest rate risk: Measure and avoid the pitfalls of duration.
3. Currency risk
Currency risk arises for U.S. investors when the investment is denominated in currencies other
than the U.S. dollar. Fluctuations in the exchange rate can affect returns on investments. If the
USD appreciates versus the local currency, the returns in terms of the USD will be lower, all else
equal. The reverse is also true. So funds like IGOV, which invest in local currency–denominated
debt, have currency risk.
Investors can overcome this risk by investing in ETFs like the Vanguard Emerging Markets
Government Bond ETF (VWOV), which invests in dollar-denominated bonds issued by
governments and government-related issuers in emerging market countries. In comparison,
currency risk is zero for domestic bond funds like LQD and USD-denominated international
bond funds like PCY. Some international bond funds use hedging techniques to overcome
currency risk, like the Vanguard Total International Bond ETF (BNDX). Currency risk in these
funds will be eliminated to the extent that these strategies are successfully executed.
Country risk
“Country risk” refers to the risk arising from the economic and political environment of a
country. The U.S. is widely perceived to have the lowest country risk in the world, with U.S.
Treasuries often the asset of choice in times of market turmoil. Some countries have higher
country risks compared to others. For example, frontier market countries like Argentina would
have higher country risk than developed market countries like Japan.
Since international bond funds invest in securities issued outside the U.S., they’ll be subject to
the risks arising from the economic and political environment of the countries whose
governments are issuing the bonds. For example, consider elections in Brazil or geopolitical
tensions in Russia and Ukraine. So international investments often require an additional
“country-risk premium” to compensate for the higher risk involved in overseas investments.
We’ll follow up this series with another tomorrow, which will include comparisons between
domestic and international bond funds in terms of returns, costs, and risks.
